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The Future Fund: what to look out for

The UK Government has announced plans for a new “Future Fund” designed to top up funding raised by early stage UK companies during the Covid-19 crisis by providing unsecured convertible loans subject to matched funding from private investors. The Future Fund is part of a total of up to £1.25bn in new funding for technology, life sciences and other fast growing companies announced by the Chancellor Rishi Sunak.

The announcement responds to considerable pressure from the tech and start-up ecosystems, whose members have pointed out that innovative, high-growth, early-stage companies, who will shape the economy of the future, have been excluded from the previous turnover-based business support schemes.

The Future Fund follows the examples set by other countries, in particular France and Germany, which have announced start-up focused relief funding of up to €4bn and up to €2bn respectively.

With a total cap of £250m (or £500m once matching funds from the private sector are included), the Future Fund is not quite on the same scale as its French and German counterparts; nevertheless, it has been cautiously welcomed within the startup and investor communities.

The fund will be administered by the British Business Bank (BBB), which is also responsible for the Coronavirus Business Interruption Loan Scheme or CBILS. Applications will open in May 2020 and will initially be open until the end of September 2020, at which point the scheme will be reviewed. No indication has yet been given as to how quickly applications are likely to be processed but the administrative effort should not be underestimated.

The Future Fund represents a significant opportunity for growth companies and their investors, as well as for the Government, which will have the opportunity to become a significant shareholder in a large number of early stage companies with huge prospects. Nevertheless, the devil is (as always) in the detail and potential applicants should ensure that they fully understand the terms before committing.

Term sheet

The Government has published an initial, indicative term sheet for Future Fund loans, a copy of which is available here.

The term sheet is highly commercial in nature and closely resembles term sheets for many VC-backed bridging funding structures, including warranties, covenants and governance rights. In other words, the Government is conscious of looking after taxpayers’ money and this is not a free lunch!

The term sheet describes the loans as “bridge funding”, since they are designed to convert into equity on the next major equity funding round of the company.

Key terms include the following:

Government funding will be between £125k and £5m per company and may only be used for working capital.

Government funding is conditional on “matched funding” being provided by private third party investors; the Government funding will be capped at 50% of the total bridge funding being provided to the company, with the balance (which is uncapped) to be provided by others sourced by the applicant company;

In order to qualify, companies must:

be private, unlisted companies registered and operating in the UK;

have raised at least £250k in aggregate from private investors in the past five years; and

pass fraud, anti-money laundering and KYC checks.

Interest is at a minimum rate of 8% (non-compounding).

The Government’s loan will convert into equity as follows:

mandatory conversion on completion of a qualifying funding round (“qualifying” meaning that the company raises fresh equity finance at least equal to the total amount of the Government and matched funding);

lender-only option to convert on completion of a smaller fundraise or on maturity of the loan;

conversion on completion of a sale or IPO if this would provide a better result for investors than redemption;

any conversion of principal to take place at a minimum discount of 20% to the valuation set by the most recent funding round (except where the most recent funding round took place prior to the bridge funding, in which case there is no discount);

on a qualifying funding round the company will have the option to pay interest in cash; otherwise, interest will convert with no discount;

conversion will be into the most senior-ranking class of shares then in issue; and

no valuation cap to be set by Government, but Government will benefit from any valuation cap set by other investors and generally from any improved terms offered to other investors.

If not previously converted, the loan will be redeemed with a 100% redemption premium (i.e. company to repay 200% of the borrowed amount) on:

maturity at the end of the 3-year term (if investors elect to be repaid rather than convert); or

completion of a sale or IPO if this would provide a better result for investors than conversion.

Points to watch for

Potential applicants should be particularly aware of the following:

Although the intention of the fund is clearly to target innovative companies, the published qualifying criteria do not specify types of qualifying business activity. Nevertheless, it is likely that the BBB will assess the nature of applicants’ businesses either generally or on a case-by-case basis.

It is not clear whether the matched funding must also take the form of convertible debt, or whether other securities such as secured debt or equity would be permitted. If the matched funding is limited to convertible debt, this may limit companies’ ability to attract other investor types (for example, those seeking EIS or SEIS relief).

In any event, subject to further analysis the funding may preclude EIS or SEIS relief for co-investors.

The 100% redemption premium means that letting the loan run to maturity will be very expensive and may complicate a sale or IPO and/or deter potential buyers or investors.

Conclusion

The Future Fund is an exciting and welcome development, which should increase the amount of money which growth companies are able to raise from their investors.

In addition, the fund may help to unlock capital from investors who might otherwise be wary of funding too high a proportion of a funding round.

It is interesting to see the Government targeting equity stakes in growth companies and it will be fascinating to see how this unfolds once those companies look to exit.

This is not a charitable initiative, nor will it be a one-size-fits-all solution. It is therefore vital that, before proceeding, potential applicants fully understand the terms and carefully model their ability to repay the funding and the dilutive effect of conversion on their cap tables.

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